Early Retirement Plan Withdrawal Tax Penalties
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Update: With the recent passing of the Consolidated Appropriations Act, 2021 passed by congress on December 21, 2020, many of these breaks and forms of aid have been extended or revised. As such, early distributions are penalty free. See this page to calculate your eligible amount for the new, second stimulus payment. If you missed the first stimulus payment and/or the second payment, learn about the Recovery Rebate Credit and how to easily claim it on when you file your 2020 Tax Return on eFile.com.
The country recognizes all 50 states as designated major disaster areas during the pandemic, so the waiving of penalties for early withdrawals has been extended. Withdraw from your retirement plan, such as a 401(k), as a last resort as this would take money away from your retirement.
What Happens When I Make Early Retirement Distributions?
The government wants you to save money for your retirement. That's why there are tax breaks like the Retirement Savings Contribution Credit and penalties for early distributions from retirement plans.
In order to discourage people from using their retirement savings for anything other than retirement income, the IRS charges a penalty of additional tax on most early withdrawals from retirement plans. In general, an early distribution, or early withdrawal, is any money you take out of a qualified retirement plan before you reach the age of 59 1/2.
The easiest and most accurate way to report an early withdrawal and to determine if you owe any taxes based on it is to start a free tax return on eFIle.com. Based on your answers to several questions, we will prepare the correct forms to report any withdrawals you make from your retirement plan.
If you need more information about this, read on.
A qualified retirement plan is any of the following:
- A Traditional IRA or a Roth IRA
- An employee plan, such as a 401(k)
- An employee annuity plan, such as a 403(a)
- A 403(b) or similar plan for employees of public schools and tax-exempt organizations
Generally, state or local government 457 plans are not considered qualified retirement plans and early distributions from these are not subject to a federal tax penalty (though there may be state penalties).
If you make an early withdrawal from a qualified retirement plan, the amount is added to your gross income unless you meet one of the early withdrawal exceptions. As part of your gross income, you will owe tax on the distribution at your normal effective tax rate. In addition to normal income tax, you will owe a penalty of additional tax on the amount of the early withdrawal unless you meet an exception.
Additional Tax Penalty for an Early Withdrawal
The tax penalty for an early withdrawal from a retirement plan is equal to 10% of the amount that is included in your income. You must pay this penalty in addition to regular income tax.
If your tax withholdings and/or estimated tax payments are not enough to cover your taxes and the penalty, you will owe money when you file your return. Find out how to pay taxes you owe.
Distributions that you roll over to another qualified retirement plan are generally not taxable and are not subject to the 10% additional tax penalty. Rollovers from a non-Roth account to a Roth account are taxable as income, but are not early distributions.
Exceptions to the Tax Penalty on Early Withdrawals
There are some exceptions to the 10% additional tax penalty. If you qualify for one of the exceptions, you still have to report your withdrawal as income, but you don't have to pay the 10% additional tax penalty.
The following exceptions to the penalty apply to early distributions from any qualified retirement plan, including IRAs:
- The distribution was made to your estate or beneficiary after your death.
- The distribution was made because you are totally and permanently disabled.
- For only IRAs, the withdrawal was made to cover qualified post-secondary education expenses.
- The withdrawal was made to cover deductible medical expenses.
- The distribution was made to pay for an IRS levy.
- The withdrawal was a Qualified Reservist Distribution (generally, one made after being called to active duty for 180 days). See information on the military and taxes.
- The distribution was made as an installment in a series of equal and periodic payments over your life expectancy, or over the life expectancy of you and your beneficiary or beneficiaries. If the retirement plan is not an IRA, you must have left employment before payments began.
The following two exceptions apply only to retirement plans that are Traditional or Roth IRAs:
- The distribution was made to pay the medical insurance premiums of you, your spouse, or a dependent while you were unemployed (or up to 60 days after re-employment).
- The distribution (up to $10,000 per spouse) was made to purchase a home for yourself, your spouse, or one of either of your parents, grandparents, children, or grandchildren if you/they are a qualifying first-time homebuyer (roughly, someone who did not own a home for the last 2 years).
The remaining exceptions below apply only to qualified retirement plans that are not Traditional or Roth IRAs:
- You received the distribution after you separated from service with your employer if you left employment during or after the year you turned age 55 (age 50 if the distributions were made from a qualified government benefit plan, if you were a public safety employee for a state or local government).
- The distribution was made to an alternate beneficiary or payee under a Qualified Domestic Relations Order.
- The distribution consisted of dividends from a qualified employee stock ownership plan, or ESOP.
Note that there are other, more rare exceptions and that the above descriptions do not take into account every detail of every situation. For more information on exceptions to the penalty on early withdrawals, refer to Publication 575 for non-IRA retirement plans and Publication 590 for IRAs. Note that Publication 590 comes in two parts: IRA Contributions and IRA Distributions.
How to Report an Early Withdrawal
You should receive a Form 1099-R that tells you exactly how much you withdrew from your retirement plan and how much tax was withheld, if any. When you e-file with eFile.com, the tax app will report these amounts directly on your Form 1040.
In most cases, you also need to fill out Form 5329, Additional Tax on Qualified Plans - eFileIT. This form is used to calculate your additional tax penalty or to claim an exception. When doing your taxes on the eFile app, the tax interview will allow the app to determine if you need to e-file this form. If there is a 1 in Box 7 of your 1099-R, you don't need to fill out Form 5329, but you still need to report the distribution as income.
The easiest way to report an early withdrawal is to prepare and e-file your tax return using eFile.com. We will select the right forms for you and help make sure Form 5329 is filled out correctly. Note that if tax was withheld and you file by mail, you generally need to attach a copy of your 1099-R to your tax return. You don't have to worry about that if you e-file.
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